When more than one creditor has a security interest in the same collateral, it might be hard to figure out who gets paid first. Article 9 of the Uniform Commercial Code (UCC) gives the standards for settling these priority disputes. However, Minnesota lenders who want to safeguard their interests need to know how these rules work in real life. This guide, prepared by Minnesota attorney David Lutz, examines the basic concepts for security interests in property other than real estate.
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What does UCC Article 9 say?
UCC Article 9 sets the rules for secured transactions involving personal property and fixtures. It sets the standards for making, improving, and deciding which security interests come first. Minnesota Statutes Chapter 336 includes Article 9, which makes it the main law governing secured lending in the state.
Article 9 gives lenders the legal framework they need to protect their loans with the borrower’s assets. But if a borrower doesn’t pay back their loan and more than one creditor has a claim on the same collateral, Article 9’s priority rules decide who gets paid first from the collateral’s sale.
Basic Rule of Priority: First to File or Get It Right
The main idea of UCC § 9-322(a)(1) is simple: the first creditor to file a financing statement or perfect their security interest usually has the most rights. This “first in time, first in right” provision gives creditors who work hard to safeguard their interests a compensation.
If Bank A files a financing statement on January 1 and Bank B files one on February 1, both saying they have a security interest in the same equipment, Bank A is first, even if Bank B’s security interest was attached to the collateral first. This shows how important it is to quickly file UCC-1 financing statements with the Minnesota Secretary of State.
Important Exceptions to the General Rule of Priority
The first-to-file rule is the default, but there are some notable exceptions that can change the order of priority:
PMSI stands for Purchase Money Security Interests
A purchase money security interest lets a creditor who helps pay for certain collateral “jump the line” in front of creditors who filed earlier. The PMSI holder must tell other secured parties before the debtor gets the inventory. When the debtor gets the collateral for equipment and other goods, the PMSI must be perfected right away or within 20 days.
Buyers in the Normal Course of Business
UCC Section 9-320(a) says that a buyer who buys goods in the normal course of business does not have to worry about any security interest that the seller has, even if the security interest is perfected and the buyer knows about it. This guideline protects business deals and stops lenders from messing with the natural flow of business.
Proceeds and property that was bought after the fact
When collateral is sold or otherwise gotten rid of, the security interest stays with the identified proceeds. The original priority of the collateral usually stays the same for the proceeds. However, this can get tricky when the proceeds come in different forms (like cash, accounts receivable, or new equipment) or when more than one creditor wants a claim on the same proceeds.
Chattel Paper and the Issue of Dual Status
Chattel paper is a type of writing that shows both a money obligation and a security interest in certain commodities. This is one of the most complicated areas. Some such examples include leases for equipment and secured installment sale contracts.
Chattel paper can cause priority conflicts since it stands for two forms of collateral: the responsibility to pay and the goods itself. A creditor who has a security interest in “all accounts and chattel paper” may have to compete with someone who bought the chattel paper and has the physical documents. Even if an earlier security interest was perfected, UCC § 9-330 grants buyers of chattel paper who give new value and take possession in good faith priority.
Intercreditor Agreements and Subordination of Contracts
Intercreditor agreements let lenders change the UCC’s default priority rules. These contracts let creditors agree on their rights and priorities, typically putting one lender’s interest below another’s, no matter when the loans were made.
Intercreditor agreements are prevalent in business loans, especially when various lenders offer distinct types of financing. For example, one lender can give working capital loans against inventory and receivables, while another lender might pay for equipment purchases. But these agreements need to be written very carefully so that they can be enforced. They should also say what happens in different default and bankruptcy situations.
Things to Think About When Going Bankrupt
When someone files for bankruptcy, UCC Article 9 priority principles are still significant, but federal bankruptcy law makes things even more complicated. The bankruptcy trustee can get rid of security interests that aren’t perfect and may question transfers that were made right before bankruptcy. Secured creditors also have to deal with the automatic stay, the need for proper protection, and the fact that the debtor might be able to use cash collateral.
In bankruptcy, lenders with fully completed security interests usually keep their priority positions. However, they must act quickly to safeguard their collateral and may need to work out cash collateral orders or suitable protection agreements with the debtor and trustee.
What Minnesota Lenders Should Do
Minnesota lenders should do the following to keep their priority position under UCC Article 9:
Before giving someone credit, do extensive UCC investigations to find out whether there are any existing security interests in the collateral. Look for not just the debtor’s present name, but also their previous names and any linked businesses.
As soon as the loan closes, file financing statements. There are tight scheduling rules for purchase money security interests, so make sure you file at the same time as the money is sent and the collateral is delivered.
Keep an eye on and keep up with UCC filings by filing continuation statements before the first five-year period ends. If you miss this date, you may lose your priority to creditors who submit later. Write clear security agreements that appropriately describe the collateral and contain stipulations for proceeds and after-acquired property when they are needed.
When more than one lender will have security interests in collateral pools that are the same or linked, think about using intercreditor agreements. Talk about priority, how to use remedies, and what happens in bankruptcy cases.
Check loan files from time to time to make sure they follow UCC rules and to see if anything has changed in the borrower’s situation that could alter collateral or priority.
When there are priority disputes
Even with the best efforts, priority conflicts can happen when borrowers don’t pay back their loans or file for bankruptcy. When this happens, lenders need skilled legal help to look over the UCC filings and other paperwork, compare the claims, and figure out the best way to safeguard their interests.
Creditors can settle priority issues by talking things out, going through receivership proceedings, or going to court. The decision typically hinges on the technical specifics of financing statements, the exact time of filings and perfection, and how well UCC priority rules are applied to the facts.
Final thoughts
When there are UCC Article 9 priority conflicts, you need to pay close attention to the technical details and think strategically about how to safeguard your secured positions. Minnesota lenders need to know these rules and consult with a lawyer who knows what they’re doing. This can make the difference between getting all their money back and losing a lot of money when borrowers don’t pay.
If you need help setting up a new secured transaction, settling a priority dispute with other creditors, or defending your rights in bankruptcy, skilled banking law lawyers can help you deal with these difficult problems and preserve your institution’s interests.
DISCLAIMER:
This article is provided for informational purposes only and does not constitute legal advice. The information contained herein is general in nature and may not apply to your specific situation. No attorney-client relationship is created by reading this article or contacting the author in response to it. For legal advice regarding your particular circumstances, please consult with a qualified attorney.
